Are you paid what you’re worth?

14 Feb 2019
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Are you paid what you’re worth? How about other people? This might sound like a simple question, but it’s actually incredibly complex and difficult to answer.

There is a theory in economics that says that workers get paid their marginal product of labor. This means that an employer pays a worker exactly the amount of money it would lose by firing that worker. The logic is intuitive — if a worker earned less than her marginal product, some other equally efficient company could make a profit by hiring her away. If she earned more, some worker with similar skills would come in and offer to do the job for less.

There are lots of ways that this theory could be wrong. It obviously assumes that markets are both extremely competitive and fluid — there’s always another company waiting to scoop up underpaid workers, and another worker waiting to replace the overpaid. In reality, employers have a lot of market power — economic research consistently finds that the fewer employers there are in an area, the less workers in that area get paid. Because it’s difficult and expensive for a worker to switch jobs, employers can afford to pay them less than their marginal product. 

So it’s likely that many employees are paid less than the amount of revenue their work generates for their company. But it’s not all bad news for workers — there are some reasons companies might want to pay workers more than their marginal product contributes. For example, as Henry Ford famously discovered, giving workers higher pay can make them work more efficiently.

In reality, these and other distortions of the imaginary perfect market probably exist all at once, and each one probably affects different workers to varying degrees. But what does the data say? The question is difficult to answer, because it’s very hard to actually know how much revenue a company would lose by firing an individual. Simply comparing average wages with average productivity, as many do, won’t give you the answer — the same people who make that comparison probably also believe that chief executive officers tend to be overpaid.